Accounting for Intra Group Transactions

8/20/2019 Accounting for Intra Group Transactions

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Upon completing this chapter readers should be able to:

LO1 explain the nature of intragroup transactions;

LO2 describe how and why intragroup dividends from both post-acquisitionand pre-acquisition earnings are eliminated on consolidation;

LO3 show how to account for intragroup sales of inventory inclusive of the

related income tax expense effects; and

LO4 show how to account for intragroup sales of non-current assetsinclusive of the related tax effects.

LEARNINGOBJECTIVES

CHAPTER 25

ACCOUNTING FORINTRAGROUPTRANSACTIONS


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CHAPTER 25: ACCOUNTING FOR INTRAGROUP TRANSACTIONS •

INTRODUCTION TO ACCOUNTING FOR INTRAGROUP

TRANSACTIONS

During the financial period it is common for separate legal entities within an economic entity to transact with each other. In

preparing consolidated financial statements, the effects of all transactions between entities within the economic entity—

which are referred to as intragroup transactions—are eliminated in full, even where the parent entity only holds

a fraction of the issued equity. Remember, in rare circumstances it might be necessary to consolidate an entity

even when no equity is owned, if it is determined that there is a capacity to determine the financing and operating

policies of the other organisation—the power element—and an entitlement to a significant level of current or

future ownership benefits—the benefit element.

Intragroup transactions include:

• the payment of dividends to group members;

• the payment of management fees to a group member;

• the transfer of tax losses between entities with or without consideration;

• intragroup sales of inventory;

• intragroup sales of non-current assets; and

• intragroup loans.

When performing the consolidation adjustments for intragroup transactions these transactions would typically be

eliminated by reversing the original accounting entries made to recognise the transactions in the separate legal entities. In

the discussion that follows, the accounting for various intragroup transactions will be considered.

25.1 DIVIDEND PAYMENTS PRE-ACQUISITION ANDPOST-ACQUISITION

NZ IAS 27 considers when a parent entity should recognise a dividend received from a subsidiary. Paragraph 38A explainsthat

An entity shall recognise a dividend from a subsidiary, jointly controlled entity or associate in profit or loss in its separate financial statements when i ts right to receive the dividends is established.

In the consolidation process it is however necessary to eliminate all dividends paid/payable to other entities within thegroup, and all intragroup dividends received/receivable from other entities within the group. Even though the separate legalentities in the group might be paying dividends to each other, it does not make sense for such dividends to be shown when thegroup is considered a single economic entity. That is, an entity cannot pay ‘dividends’ to itself. The only dividends that should

be shown in the consolidated financial statements would be dividends paid to parties external to the economic entity or group,that is, to the shareholders of the parent entity and to the non-controlling interests. Non-controlling interests will be discussedin depth in the next chapter. The elimination of intragroup dividends is consistent with the requirements of NZ IAS 27‘Consolidated and Separate Financial Statements’, paragraph 20, which requires all intragroup balances, transactions, incomeand expenses to be eliminated in full on consolidation.

DIVIDENDS OUT OF POST-ACQUISITION PROFITS

Only dividends paid externally should be shown in the consolidated financial statements. For example, in Figure 25.1,Subsidiary Limited is 100 per cent owned by Parent Entity Limited. Subsidiary Limited pays $1000 in dividends to Parent Entity

Limited and Parent Entity Limited pays $4000 in dividends to its shareholders. The only dividends being paid externally, andhence the only dividends to be shown in the consolidated financial statements, will be the dividends paid to the shareholdersof Parent Entity Limited, that is the $4000 in dividends. The dividends paid to the parent entity by the 100 per cent ownedsubsidiary will be eliminated on consolidation.

Worked Example 25.1 shows the consolidation of financial statements when a dividend has been paid by a subsidiarycompany after acquisition.

intragroup transa

Transaction undert

between separate

legal entities within

economic entity.


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816 • PART 7: ACCOUNTING FOR EQUITY INTERESTS IN OTHER ENTITIES

WORKED EXAMPLE 25.1■ DIVIDEND PAYMENTS BY A SUBSIDIARY OUT OF POST-ACQUISITION EARNINGS

Angela Limited owns all the contributed equity of Ballo Limited. Angela Limited acquired its 100 per cent interest in Ballo Limited

on 1 April 2011 for a cost of $800 000 representing the fair value of the consideration transferred. The equity of Ballo Limited onthe date of acquisition was:

$

Contributed equity 500 000

Retained earnings 300 000

800 000

It is considered that the assets of Ballo Limited are fairly stated at the date that Angela Limited acquires its shares. There

is therefore no goodwill to be recognised on acquisition. On 31 March 2012 the directors of Ballo Limited proposed and

communicated their decision to shareholders to pay a dividend of $50 000. Angela Limited recognises dividend income when it is

declared by Ballo Limited. The financial statements of Angela Limited and Ballo Limited at 31 March 2012 are as follows:

ANGELA LIMITED BALLO LIMITED ($000) ($000)

RECONCILIATION OF OPENING AND CLOSING RETAINED EARNINGS

Profit before tax 200 100

Income tax expense 50 40

Profit for the year 150 60

Retained earnings—1 April 2011 400 300

550 360

less Dividends proposed 70 50

Retained earnings—31 March 2012 480 310

STATEMENT OF FINANCIAL POSITION

EquityContributed equity 500 500


Liabilities

Accounts payable 1 000 100

Dividends payable 70 50

2 050 960

Figure 25.1

Dividends being paid by

members of an economic

entity

$1000

dividends

$4000dividends Parent Entity

Limited

Subsidiary Limited

Economicentity

Shareholdersof Parent

Entity Limited


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ANGELA LIMITED BALLO LIMITED

($000) ($000)

Assets

Cash 100 70

Accounts receivable 50 130

Dividends receivable 50 –

Inventory 200 160

Plant and equipment 850 600

Investment in Ballo Limited 800 –

2 050 960

Required •

(a) Prepare the journal entries that would have appeared in the accounting records of the separate legal entities, Angela Limited

and Ballo Limited, to account for the dividends proposed by Ballo Limited.

(b) Prepare the consolidation worksheet for Angela Limited and its controlled entity.

Solution to Worked Example 25.1

(a) Journal entries that would have appeared in the accounting records of Angela Limited and Ballo Limited, to account for the

dividends proposed by Ballo Limited.

Entry in records of Ballo Limited

31 March 2012 Dr Dividend proposed (statement of

changes in equity) 50 000

Cr Dividend payable (statement of

financial position) 50 000

Dividends proposed on 31 March 2012

As Angela Limited accrues its dividend income, it would have the following entry in its own accounting records:

Entry in records of Angela Limited

31 March 2012 Dr Dividend receivable (statement of

financial position) 50 000

Cr Dividend income (statement of

comprehensive income) 50 000

Dividends receivable from Ballo Limited

Since it does not make sense to retain the intragroup payables and receivables in the consolidated financial statements (one

cannot owe money to oneself), these are eliminated on consolidation. Only dividends payable to shareholders of the holding

company are shown in the consolidated financial statements.

(b) Consolidation worksheet for Angela Limited and its controlled entity

From the economic entity’s perspective, Ballo Limited has paid no dividends to external parties. This means that any

dividends paid by Ballo Limited must be eliminated for consolidation purposes. The elimination entries would be the reverse

of those shown above, as follows:

(a) Elimination entry for Ballo Limited

31 March 2012 Dr Dividend payable 50 000

Cr Dividend proposed 50 000

Eliminating dividends proposed by Ballo Limited at 31 March 2012

(b) Elimination entry for Angela Limited

31 March 2012 Dr Dividend income (part of profit before tax) 50 000

Cr Dividend receivable 50 000

Eliminating dividends receivable from Ballo Limited

As was stressed in Chapter 24, consolidation journal entries are not made in the journals of either company but in a

separate consolidation journal (or worksheet). Apart from the consolidation entries provided in (a) and (b) of this worked

example, the investment in Ballo Limited also needs to be eliminated.


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(c) Eliminating investment in Ballo Limited

The workings to eliminate the investment in Ballo Limited held by Angela Limited would be the following:

ELIMINATION OF INVESTMENT IN BALLO LIMITED BALLO ELIMINATE

LIMITED PARENT 100%

($) ($)

Fair value of consideration transferred 800 000

less Fair value of identifiable assets acquired and liabilities assumed

Contributed equity 500 000 500 000

Retained earnings—on acquisition 300 000 300 000

800 000

Goodwill on acquisition date –

This elimination entry would be:

31 March 2012 Dr Contributed equity 500 000

Dr Retained earnings 300 000

Cr Investment in Ballo Limited 800 000

Eliminating investment in Ballo Limited

The consolidation worksheet can now be prepared, as follows:

Angela Limited and its controlled entity

Consolidation worksheet for the period ending 31 March 2012

ELIMINATIONS ANDANGELA BALLO ADJUSTMENTS CONSOLIDATED

LIMITED LIMITED DR CR STATEMENTS

($000) ($000) ($000) ($000) ($000)


Profit before tax 200 100 50(b) 250

Income tax expense 50 40 90

Profit for the year 150 60 160

Retained earnings—1 April 2011 400 300 300(c) 400

550 360 560

less Dividends proposed 70 50 50(a) 70

Retained earnings—31 March 2012 480 310 490


Equity

Contributed equity 500 500 500(c) 500

Retained earnings b/d 480 310 490

Liabilities

Accounts payable 1 000 100 1 100

Dividends payable 70 50 50(a) 70

2 050 960 2 160

Assets

Cash 100 70 170

Accounts receivable 50 130 180

Dividends receivable 50 – 50(b) –

Inventory 200 160 360

Plant and equipment 850 600 1 450

Investment in Ballo Limited 800 – 800(c) –

2 050 960 900 900 2 160

The retained earnings balance in the consolidated financial statements is $490 000 as at 31 March 2012. This balance

represents the retained earnings of Angela Limited ($480 000) plus the increment in retained earnings of Ballo Limited

($10 000) since the date on which Ballo Limited was acquired (the post-acquisition increment).


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DIVIDENDS OUT OF PRE-ACQUISITION PROFITS

In Worked Example 25.1, the dividends were paid out of post-acquisition profits. A dividend paid from pre-acquisitionprofits will occur when an investor acquires a controlling interest in a subsidiary, and the shares have been acquired ‘cumdiv’—the term used to refer to shares being bought with a dividend entitlement. Dividends paid from profits earned prior toacquisition are, in effect, a return of part of the net assets originally acquired. These dividends represent a return of part ofthe investment in the subsidiary and, as such, are not accounted for as revenue of the investor. This means that any goodwillor gain on bargain purchase will not change as the payment of the dividends results in a decrease in the investor’s share ofthe earnings of the subsidiary’s net assets at the date of acquisition. Although not formally considered by either NZ IFRS 3‘Business Combinations’ or NZ IAS 27, the accounting treatment for dividends paid from pre-acquisition profits was provided

by NZ IFRS 3’s predecessor, FRS-36 ‘Accounting for Acquisitions Resulting in Combinations of Entities or Operations’,paragraph 5.45, which stated:

A distribution received from a subsidiary must be accounted for in the investor’s own financial statements as a reduction inthe cost of acquisition to the extent that the distribution is from pre-acquisition equity of the subsidiary.

Dividends paid from pre-acquisition profits are considered in Worked Example 25.2.

WORKED EXAMPLE 25.2■ DIVIDENDS PAID OUT OF PRE-ACQUISITION EARNINGS

Sunshine Limited acquired all the issued capital of Sunrise Limited for a cash payment of $500 000 representing the fair value of

the consideration transferred, on 31 March 2012. The statements of financial position of both entities immediately following the

acquisition are:

SUNSHINE LIMITED SUNRISE LIMITED

($000) ($000)

Non-current assets

Plant 1 480 600

Investment in Sunrise Limited 500 –

Current assets

Cash 20 15


2 300 660

Non-current liabilities

Loans 800 180

Current liabilities

Accounts payable 100 30Equity

Contributed equity 1 000 200


2 300 660

Immediately following the acquisition (that is, on the same day), a dividend of $200 000 was proposed by Sunrise Limited.

The financial statements just provided do not reflect this dividend payment. The receivable will need to be treated as a reduction

in the investment in Sunrise Limited account in the statement of financial position of Sunshine Limited.

Required • Provide the consolidated statement of financial position of Sunshine Limited and Sunrise Limited as at

31 March 2012.


Recognition of the dividend payable in the financial statements of Sunrise LimitedSunrise Limited would have recorded the dividend payable to Sunshine Limited by means of the following journal entry:

31 March 2012 Dr Dividend paid 200 000

Cr Dividend payable 200 000

Dividends payable by Sunrise Limited


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Recognition of the dividend receivable in the financial statements of Sunshine Limited

Sunshine Limited would have recorded the dividend receivable of pre-acquisition profits of Sunrise Limited in the following way:

31 March 2012 Dr Dividend receivable 200 000

Cr Investment in Sunrise Limited 200 000

Payment of dividends from pre-acquisition profits

Dividends paid out of pre-acquisition profits should be accounted for by reducing the investment, rather than by the investor treating

the receipt as income. Only dividends out of the investee’s post-acquisition profits are treated as income in the books of the investor.

It should be noted that the above entry (unlike the consolidation entries to follow) is made in the books of Sunshine Limited.

Consolidation journal entries(a) Elimination of investment in Sunrise Limited and recognising goodwill/gain on bargain purchase

Given that the investment in Sunrise Limited account would have been reduced by $200 000 (as would the retained earnings

shown in the financial statements of Sunrise Limited), the workings to eliminate the investment held by Sunshine Limited in

Sunrise Limited are as follows:

ELIMINATION OF INVESTMENT IN SUNRISE LIMITED ELIMINATE

SUNRISE LIMITED PARENT 100%

($) ($)





450 000

Goodwill on acquisition date 50 000


Dr Retained earnings ($250 000 – $200 000

dividends from pre-acquisition profit) 50 000

Dr Goodwill 50 000


Eliminating investment in Sunrise Limited and recognising goodwill

The intragroup payables and receivables will also need to be eliminated, since from the group perspective the group cannot

owe itself any money.

(b) Eliminating intragroup receivable and payable

31 March 2012 Dr Dividend payable 200 000 Cr Dividend receivable 200 000

Eliminating dividends receivable and payable


Sunshine Limited and its controlled entity


ELIMINATIONS AND

SUNSHINE SUNRISE ADJUSTMENTS CONSOLIDATED


($000) ($000) ($000) ($000) ($000)

Non-current assets

Plant 1 480 600 2 080Investment in Sunrise Limited 300 – 300(a) –

Goodwill – – 50(a) 50

Current assets

Cash 20 15 35


Dividends receivable 200 – 200(b) –

2 300 660 2 510


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ELIMINATIONS AND



($000) ($000) ($000) ($000) ($000)


Loans 800 180 980

Current liabilities


Dividend payable – 200 200(b) –

Equity

Contributed equity 1 000 200 200(a) 1 000

Retained earnings 400 50 50(a) 400

2 300 660 2 510

The consolidated statement of financial position would be as follows:

Sunshine Limited and its controlled entity

Consolidated statement of financial position at 31 March 2012

GROUP SUNSHINE LIMITED

($000) ($000)

Non-current assets

Plant 2 080 1 480Investment in Sunrise Limited – 300

Goodwill 50 –

2 130 1 780

Current assets

Cash 35 20


Dividend receivable – 200

380 520

Total assets 2 510 2 300


Loans 980 800

Current liabilities

Accounts payable 130 100

Total liabilities 1 110 900

Net assets 1 400 1 400

Equity



1 400 1 400

The dividend payment from pre-acquisition reserves will not affect the amount of goodwill recognised on consolidation.

Had the pre-acquisition dividend not been paid by Sunrise Limited, the investment would have been recorded in Sunshine

Limited’s financial statements at $500 000 (not $300 000) and the retained earnings of Sunrise Limited would have been

$250 000 (and not $50 000). In the absence of the pre-acquisition dividend, the entry to eliminate the investment in SunriseLimited would have been:


Dr Retained earnings—1 April 2011 250 000

Dr Goodwill 50 000


Eliminating investment in Sunrise Limited and recognising goodwill on acquisition

Note: The entry to eliminate the intragroup dividend receivable and payable shown above would also have to be made.


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25.2 INTRAGROUP SALE OF INVENTORY

Entities that are related often sell inventory to one another in what is known as an intragroup sale of inventory. From the group’sperspective, revenues should not be recognised until an external sale of inventory has taken place—that is, when inventoryhas been sold to parties outside the group. This is consistent with the NZ IAS 27, paragraph 20, requirement for intragroup

balances, transactions, income and expenses to be eliminated in full on consolidation. Commentary paragraph 21 expands onthis requirement by stating that any profits or losses that result from intragroup transactions that are recognised in assets suchas inventory and fixed assets are to be eliminated in full on consolidation. The rationale for these adjustments is that the entitycannot transact with itself.

The following example will illustrate this requirement. Assume Company A sells $100 000 worth of inventory toCompany B, which in turn sells it to a party outside of the economic entity for an amount of $150 000 (see Fig. 25.2). If thesales were simply aggregated in the consolidation process, it would appear that the economic entity’s total sales were $250 000.From the economic entity’s perspective this would be incorrect. The only sales that should appear in the consolidated financialstatements are those made to parties external to the group, in this case $150 000.

Of course it might be possible at the end of the reporting period for some or all of the inventory sold within the groupto still be on hand. Assume that half of the inventory sold by Company A to Company B is still on hand at the end of thereporting period and, further, that the total amount of inventory transferred from Company A to Company B at a sales priceof $100 000 actually cost Company A $70 000 to manufacture. With half of the inventory still on hand, effectively this wouldmean that there is inventory on hand that appears in Company B’s financial statements at a cost to Company B of $50 000,

which only cost the group $35 000 to manufacture. As established in earlier chapters, an entity in New Zealand must recordinventory at the lower of cost and net realisable value (see Chapter 6 for an explanation of how to value inventory). This meansthat inventory needs to be written down by $15 000 for the purposes of the consolidated financial statements (which have astheir focus the economic entity). In the financial statements of Company B, as a separate legal entity, it is correct to leave theinventory at its cost to Company B, that is $50 000.

Remember that although unrealised profits are being eliminated from the consolidated financial statements fromCompany A’s perspective, the profits have been earned, leading to a liability for tax. The economic entity does not pay tax

on a collective basis as the individual legal entities pay tax on their own account. The Inland Revenue Department assessesincome earned by the separate legal entities without any consideration of consolidation adjustments. From the group’sperspective, an amount of profit related to the sale has not been realised and should not be included in the economicentity’s profits. Therefore, if tax has been paid by one of the separate legal entities (for example, Company A), this representsfrom the group’s perspective a pre-payment of tax (a deferred tax asset) as this income will not be earned by the economicentity until the inventory is sold outside the group. Worked Example 25.3 considers how to account for unrealised profitin closing inventory.

Figure 25.2

Intragroup and external

sales of inventory

$100 000

$150 000

Company A

Company B

Economicentity

Outsideentity


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WORKED EXAMPLE 25.3■ UNREALISED PROFIT IN CLOSING INVENTORY

Big Limited owns 100 per cent of the contributed equity of Little Limited. These shares were acquired on 1 April 2011 for

$1 million, representing the fair value of the consideration transferred, when the equity of Little Limited was:

$


Retained earnings on acquisition—1 April 2011 400 000

900 000

All assets of Little Limited were fairly stated on acquisition date. The directors believe that during the year, the value of the

goodwill has been impaired by an amount of $10 000.

During the 2012 reporting period Little Limited sold inventory to Big Limited at a sales price of $200 000. The inventory cost Little

Limited $120 000 to produce. At 31 March 2012 half of the inventory is still on hand with Big Limited. The tax rate is 30 per cent.

The financial statements of Big Limited and Little Limited at 31 March 2012 are as follows:

BIG LIMITED LITTLE LIMITED

($000) ($000)


Revenue 1 200 400

Opening inventory 510 120

Purchases 590 320

less Closing inventory 600 300

Cost of goods sold 500 140

Gross profit 700 260

less Other expenses 60 30

Other income 70 25




Retained earnings—1 April 2011 1 000 400

1 510 555

Dividends paid 200 40



Equity


Retained earnings 1 310 515

Current liabilities



Loans 600 250

6 010 1 350

Current assets

Cash 250 25

Accounts receivable 150 175Inventory 600 300

Non-current assets

Land 1 440 400

Plant 2 470 400

Investment in Little Limited 1 000 –

Deferred tax asset 100 50

6 010 1 350


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Required • Prepare the consolidation worksheet for Big Limited and its controlled entity for the reporting period ended

31 March 2012.


(a) Eliminating investment in Little Limited and recognising goodwill

Workings to eliminate investment in subsidiary

ELIMINATION OF INVESTMENT IN LITTLE LIMITED LITTLE ELIMINATE

LIMITED PARENT 100%

($) ($)

Fair value of consideration transferred 1 000 000




900 000


Consolidating journal entries



Dr Goodwill 100 000

Cr Investment in Little Limited 1 000 000

Eliminating investment in Little Limited and recognising goodwill on acquisition

(b) Recognising the impairment of goodwill

After initial recognition, any assets acquired, liabilities assumed or incurred and equity instruments issued in a business

combination should be accounted for and measured in accordance with the appropriate NZ IFRSs for those items, depending

on their nature. After its initial recognition, goodwill acquired in a business combination is measured at cost less any

accumulated impairment losses. NZ IAS 36 ‘Impairment of Assets’ requires goodwill to be tested for impairment annually,

or more frequently if events or changes in circumstances indicate that the asset might be impaired. Extensive discussion on

how impairment losses attributable to goodwill are calculated is provided in NZ IAS 36 ‘Impairment of Assets’.

31 March 2012 Dr Other Expenses—impairment of goodwill 10 000

Cr Goodwill—accumulated impairment 10 000

Recognising goodwill impairment expense

In relation to the changes in the carrying amount of goodwill, which would be brought about by actions such as the

recognition of impairment losses, NZ IFRS 3, paragraph 61 requires entities to disclose information that enables users

of its financial statements ‘to evaluate the financial effects of adjustments recognised in the current reporting period

that relate to business combinations that occurred in the period or previous reporting periods’. In operationalising the

requirements of paragraph 61, NZ IFRS 3, paragraph B67(d), provides the following detailed guidance:

(d) a reconciliation of the carrying amount of goodwill at the beginning and end of the reporting period showing separately:

(i) the gross amount and accumulated impairment losses at the beginning of the reporting period.

(ii) additional goodwill recognised during the reporting period, except goodwill included in a disposal group that, on

acquisition, meets the criteria to be classified as held for sale in accordance with NZ IFRS 5 Non-current Assets

Held for Sale and Discontinued Operations.

(iii) adjustments resulting from the subsequent recognition of deferred tax assets during the reporting period in

accordance with paragraph 67.

(iv) goodwill included in a disposal group classified as held for sale in accordance with NZ IFRS 5 and goodwill

derecognised during the reporting period without having previously been included in a disposal group classified as

held for sale.

(v) impairment losses recognised during the reporting period in accordance with NZ IAS 36. (NZ IAS 36 requires

disclosure of information about the recoverable amount and impairment of goodwill in addition to this

requirement.)

(vi) net exchange rate differences arising during the reporting period in accordance with NZ IAS 21 The Effects of

Changes in Foreign Exchange Rates.

(vii) any other changes in the carrying amount during the reporting period.

(viii) the gross amount and accumulated impairment losses at the end of the reporting period.


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(c) Eliminating intragroup sales

The intragroup sales need to be eliminated because, from the perspective of the economic entity, no sales have occurred.

This will ensure that the turnover of the economic entity is not overstated.

31 March 2012 Dr Revenue—sales Little Limited 200 000

Cr Purchases—Big Limited 200 000

Eliminating intragroup sales

If a perpetual inventory system was in use the above credit entry would be to cost of goods sold. (Cost of goods sold equals

opening inventory plus purchases less closing inventory. So any reduction in purchases leads to a reduction in cost of goods sold.)

(d) Eliminating unrealised profit in closing inventory

The total profit earned by Little Limited on the sale of the inventory was $80 000. Since some of this inventory remains in

the economic entity, this amount has not been fully earned. In this case, half of the inventory is still on hand. Therefore, the

unrealised profit amounts to $40 000. In accordance with NZ IAS 2 ‘Inventories’, the inventory must be valued at the lower

of cost and net realisable value. This means that, on consolidation, the value of recorded inventory must be reduced, because

the amount shown in the financial statements of Big Limited exceeds what the inventory cost the economic entity (that is, the

profit element must be removed).

31 March 2012 Dr Closing inventory—profit and loss 40 000

Cr Inventory 40 000

Eliminating unrealised profit in closing inventory

If the perpetual inventory system were employed, the above debit entry would be to cost of goods sold. Cost of goods sold is

increased by the unrealised profit in closing inventory because reducing closing inventory effectively increases cost of goods

sold. (Remember, cost of goods sold equals opening inventory plus purchases, less closing inventory.) The effect of the

above entries is to adjust the value of inventory so that it reflects the cost of the inventory to the group.

(e) Consideration of the tax paid on the sale of inventory that is still held within the group

From the group’s perspective, $40 000 has not been earned. However, from Little Limited’s perspective (as a separate legal

entity) the full amount of the sale has been earned. This will attract a tax liability in Little Limited’s financial statements of

$24 000 (30 per cent of $80 000). However, from the group’s perspective some of this, $12 000 ($40 000 × 30 per cent),

will represent a prepayment of tax, as the full amount has not been earned by the group even if Little Limited is obliged to

pay the tax. (Remember that tax is assessed on the separate legal entities, not on the consolidated profits.)

31 March 2012 Dr Deferred tax asset 12 000

Cr Income tax expense 12 000

Recognising tax effect on unrealised profit in inventory

(f) Eliminating intragroup dividends

Any intragroup dividends must also be eliminated on consolidation (as an entity cannot pay itself a dividend).

31 March 2012 Dr Other income—dividend revenue 40 000

Cr Dividends paid 40 000 Eliminating intragroup dividends


Big Limited and its controlled entity


ELIMINATIONS AND


LIMITED LIMITED DR DR STATEMENTS

($000) ($000) ($000) ($000) ($000)

RECONCILIATION OF OPENING AND CLOSING

RETAINED EARNINGS

Revenue 1 200 400 200(c) 1 400

Opening inventory 510 120 630

Purchases 590 320 200(c) 710

less Closing inventory 600 300 40(d) 860

Cost of goods sold 500 140 480

Gross profit 700 260 920

less Other expenses 60 30 10(b) 100

Other income 70 25 40(f) 55


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ELIMINATIONS AND



($000) ($000) ($000) ($000) ($000)

Profit before tax 710 255 875

Income tax expense 200 100 12(e) 288


Retained earnings—1 April 2011 1 000 400 400(a) 1 000

1 510 555 1 587

Dividends paid 200 40 40(f) 200

Retained earnings—31 March 2012 1 310 515 1 387


Equity


Retained earnings b/d 1 310 515 1 387

Current liabilities



Loans 600 250 850

6 010 1 350 6 422

Current assets

Cash 250 25 275


Inventory 600 300 40(d) 860

Non-current assets

Land 1 440 400 1 840

Plant 2 470 400 2 870

Investment in Little Limited 1 000 – 1 000(a) –

Deferred tax asset 100 50 12(e) 162

Goodwill – – 100(a) 100

Goodwill—accum. Impairment – – 10(b) (10)

6 010 1 350 1 302 1 302 6 422

The consolidated financial statements can now be prepared, as follows:


Consolidated statement of comprehensive income for the year ended 31 March 2012

GROUP BIG LIMITED

($000) ($000)

Revenue 1 400 1 200



Other income 55 70

Other expenses (100) (60)




Other comprehensive income – –

Total comprehensive income for the year 587 510


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Statement of changes in equity for the year ended 31 March 2012

GROUP

CONTRIBUTED RETAINED

EQUITY EARNINGS TOTAL EQUITY

($000) ($000) ($000)

Balance at 1 April 2011 4 000 1 000 5 000


Distributions—Dividends (200) (200)

Balance at 31 March 2012 4 000 1 387 5 387

Big Limited


BIG LIMITED


EQUITY EARNINGS TOTAL

($000) ($000) ($000)

Balance at 1 April 2011 4 000 1 000 5 000


Distributions (200) (200)Balance at 31 March 2012 4 000 1 310 5 310



GROUP BIG LIMITED

($000) ($000)

Equity


Retained earnings 1 387 1 310

Current liabilities


Non-current liabilitiesLoans 850 600

6 422 6 010

Current assets

Cash 275 250


Inventory 860 600

Non-current assets

Land 1 840 1 440

Plant 2 870 2 470

Investment in Little Limited – 1 000


Goodwill 90 –

6 422 6 010

UNREALISED PROFIT IN OPENING INVENTORY

When it is time for Big Limited and its controlled entities of Worked Example 25.3 to prepare the consolidation adjustmentsat the end of the following reporting period, there will be unrealised profits in opening inventory. Remember that theconsolidation journal entries do not affect the financial statements of the individual legal entities and, therefore, at the beginning


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of the financial period, the cost of the opening inventory held by one of the entities within the group will be overstated fromthe group’s perspective.

The closing retained earnings of Little Limited in the last year (opening retained earnings this year) will also be overstatedfrom the group’s perspective as it will include a gain on the intragroup sale of inventory. In the consolidation adjustmentsthe income from the previous period, in which the inventory was still on hand, needs to be shifted to the period in whichthe inventory will ultimately be sold to parties external to the economic entity. The statement of comprehensive incomeconsolidation entries at the end of the following year, that is, at 31 March 2013, would be:


Cr Opening inventory 40 000 Eliminating unrealised profit in opening inventory

Remember that reducing the value of opening inventory will reduce the cost of goods sold. This entry will effectively shiftthe income from 2012 to 2013 (the period in which the sale to an external party actually occurred). With higher profits this

will lead to a higher tax expense that is based upon the accounting profit with the adoption of tax-effect accounting.

Dr Income tax expense 12 000

Cr Retained earnings—1 April 2012 12 000

Income tax expense attributable to opening inventory

Any profits in opening inventory on 1 April 2012 will also need to be accounted for. Note in the above scenario that the balance of $12 000 in the deferred tax asset account raised in the previous year has not been reversed. Has a mistake beenmade? No! Remember that all consolidation adjustments are undertaken on a worksheet that is started ‘fresh’ each year. Prior

adjustments do not accumulate in any ledger accounts. This means that in 2013, there is no amount residing in a deferred taxasset ledger account that needs to be reversed. The treatment of unrealised profit in opening inventory is shown in WorkedExample 25.4.

WORKED EXAMPLE 25.4■ UNREALISED PROFIT IN OPENING INVENTORY

During the 2013 reporting period, Little Limited sold a further $220 000 worth of inventory to Big Limited. The inventory cost Little

Limited $160 000 to produce. At 31 March 2013, Big Limited had inventory worth $55 000 on hand that had been purchased

from Little Limited. In addition, the directors believe that at 31 March 2013 goodwill had been impaired by a further $20 000.

The financial statements of Big Limited and Little Limited at 31 March 2013 are as follows:


($000) ($000)

)RECONCILIATION OF OPENING AND CLOSING RETAINED EARNINGS

Revenue 1 500 550

Opening inventory 600 300

Purchases 950 495

less Closing inventory 750 615



less Other expenses 70 40

Other revenue 90 30



Profit for the year 400 230Retained earnings—1 April 2012 1 310 515

1 710 745

Dividends paid 200 50



16/44



($000) ($000)


Equity


Retained earnings 1 510 695

Current liabilities


Non-current liabilitiesLoans 590 240

6 240 1 525

Current assets

Cash 270 35


Inventory 750 455

Non-current assets

Land 1 440 400

Plant 2 450 390

Investment in Little Limited 1 000 –


6 240 1 525

Required • Prepare the consolidation worksheet for Big Limited and its controlled entity for the reporting period ended

31 March 2013.


The first step is to do the workings that enable the consolidation journal entry to be prepared.

(a) Eliminating investment in Little Limited and recognising goodwill

ELIMINATION OF INVESTMENT IN LITTLE LIMITED LITTLE ELIMINATE

LIMITED PARENT 100%

($) ($)

Fair value of consideration transferred 1 000 000




900 000




Dr Goodwill 100 000

Cr Investment in Little Limited 1 000 000

Eliminating investment in Little Limited and recognising goodwill on acquisition

(b) Recognising goodwill impairment expense

This entry recognises the goodwill impairment loss for the period. Note that the cumulative effect of goodwill impairment

loss in the previous period must also be taken into account. This is achieved by debiting opening retained earnings with the

cumulative goodwill impairment loss to the beginning of the current period.

31 March 2013 Dr Other expenses—impairment of goodwill 20 000



Recognising current and previous years’ goodwill impairment loss


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(c) Eliminating intragroup sales

The intragroup sales need to be eliminated because, from the perspective of the economic entity, no sales have occurred.

This will ensure that the turnover of the economic entity is not overstated.

31 March 2013 Dr Revenue—sales Little Limited 220 000

Cr Purchases—Big Limited 220 000

Eliminating intragroup sales

(d) Eliminating unrealised profit in opening inventory

If unrealised profit in opening inventory is not eliminated, opening inventory will be overstated from the group perspective. At

the beginning of the current reporting period the unrealised profit amounting to $40 000 needs to be shifted to the period inwhich the inventory will ultimately be sold to parties outside the group. As the perpetual inventory system is being employed

in this example, the following entry must be made for consolidation purposes.

31 March 2013 Dr Retained earnings—1 April 2012 40 000

Cr Opening inventory 40 000

Eliminating unrealised profit in opening inventory

(e) Consideration of the tax paid on the sale of inventory held within the group at the beginning of the reporting period

Reducing the value of opening inventory reduces the cost of goods sold. The entry made in (d) above effectively shifts the

income from 2012 to 2013. Higher profits lead to a higher income tax expense. On the assumption that the whole of the

unrealised profit in opening inventory has been realised in the current period, a corresponding increase in the income tax

expense of $12 000 ($40 000 × 30 per cent) must be recognised.

31 March 2013 Dr Income tax expense 12 000

Cr Retained earnings—1 April 2012 12 000 Income tax expense attributable to opening inventory

(f) Eliminating unrealised profit in closing inventory

The total profit earned by Little Limited on the sale to Big Limited of the $220 000 inventory in 2013 was $60 000. As

25 per cent of this inventory ($55 000 of $220 000)—or $55 000—remains in the economic entity, this amount has

not been fully earned. In 2013, as 25 per cent of the inventory is still on hand, this means the unrealised profit amounts

to $15 000. On consolidation, the value of recorded inventory must be reduced as the amount shown in the financial

statements of Big Limited exceeds what the inventory cost the economic entity.

31 March 2013 Dr Closing inventory—(statement of

comprehensive income) 15 000

Cr Inventory—(statement of financial position) 15 000


Under a periodic inventory system, the above debit entry would be to closing inventory—profit and loss. The cost of goods

sold is increased by the unrealised profit in closing inventory because reducing closing inventory effectively increases cost of

goods sold. The effect of the above entries is to adjust the value of inventory so that it reflects the cost of the inventory to

the group.

(g) Consideration of the tax paid on the sale of inventory that is still held within the group

From the group’s perspective, $15 000 has not been earned. However, from Little’s perspective (as a separate legal entity)

the full amount of the sale has been earned. This will attract a tax liability in Little Limited’s financial statements of $18 000

(30% of $60 000). From the group’s perspective, some of this, $4500 ($15 000 × 30%), will represent a prepayment of tax,

as the full amount has not been earned by the group even if Little Limited is obliged to pay the tax.



Income tax expense attributable to unrealised profit in closing inventory

(h) Eliminating intragroup dividends

Any intragroup dividends must also be eliminated on consolidation (as an entity cannot pay itself a dividend).

31 March 2013 Dr Other income—dividend revenue 50 000

Cr Dividends paid 50 000

Eliminating intragroup dividends



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Consolidation worksheet for the year ended 31 March 2013

ELIMINATIONS AND

BIG LITTLE ADJUSTMENTS CONSOLIDATED


($000) ($000) ($000) ($000) ($000)


RETAINED EARNINGS

Revenue 1 500 550 220(c) 1 830.0Opening inventory 600 300 40(d) 860.0

Purchases 950 495 220(c) 1225.0

less Closing inventory 750 615 15(f) 1350.0

Cost of goods sold 800 180 735.0

Gross profit 700 370 1095.0

less Other expenses 70 40 20(b) 130.0

Other income 90 30 50(h) 70.0

Profit before tax 720 360 1 035.0

Income tax expense 320 130 12(e) 4.5(g) 457.5

Profit for the year 400 230 577.5

Retained earnings—1 April 2012 1 310 515 400(a) 12(e)

10(b)

40(d) 1 387.0

1 710 745 1 964.5

Dividends paid 200 50 50(h) 200.0

Retained earnings—31 March 2013 1 510 695 1 764.5


Equity

Contributed equity 4 000 500 500(a) 4 000.0

Retained earnings b/d 1 510 695 1 764.5

Current liabilities

Accounts payable 140 90 230.0

Non-current liabilitiesLoans 590 240 830.0

6 240 1 525 6 824.5

Current assets

Cash 270 35 305.0

Accounts receivable 220 190 410.0

Inventory 750 455 15(f) 1 190.0

Non-current assets

Land 1 440 400 1 840.0

Plant 2 450 390 2 840.0

Investment in Little Limited 1 000 – 1 000(a) –

Deferred tax asset 110 55 4.5(g) 169.5

Goodwill – – 100 (a) 100.0

Accumulated impairment loss – – 30(b) (30.0)

6 240 1 525 6 824.5


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25.3 SALE OF NON-CURRENT ASSETS WITHIN THE GROUP

Intragroup transactions are not limited to the sale of inventory. It is also common for non-current assets to be sold within agroup. As with inventory, for the purposes of preparing the financial statements for the economic entity, the assets need to be

valued as if the intragroup sale had not occurred. This means that the non-current asset must be restated to the original costor revalued amount. Any unrealised profits on the sale will need to be eliminated.

Because the separate entity that acquired the asset would be depreciating the asset on the basis of the cost to itself, which might be more or less than the cost to the economic entity, there will also be a need for adjustments to depreciation(for depreciable assets) as a result of intragroup sales of non-current assets. Further, from the economic entity’s perspective,no gain or loss on sale should be recorded in the financial statements—in the consolidated financial statements thereshould be no income tax expense related to any gain on the sale. However, there will be tax implications for the separatelegal entity’s financial statements. This means that timing differences might also arise as a result of intragroup sales of non-current assets. In Worked Example 25.5 the intragroup sales of a non-current asset, whose useful life remains unchanged,is examined.

WORKED EXAMPLE 25.5■ INTRAGROUP SALE OF A NON-CURRENT ASSET WHERE USEFUL LIFE REMAINS UNCHANGED

On 1 April 2011, Eddie Limited acquired a hundred per cent of Sandy Limited for $850 000 representing the fair value of the

consideration transferred, when the equity of Sandy Limited was as follows:

$

Contributed equity 500 000Retained earnings 300 000

800 000

All the assets of Sandy Limited were fairly stated on acquisition date. On 1 April 2011, Eddie Limited sells an item of plant to

Sandy Limited for $780 000. This plant cost Eddie Limited $1 million, was four years old and had accumulated depreciation of

$400 000 at the date of the sale. The remaining useful life of the plant is assessed as six years, and the tax rate is 30 per cent.

At 31 March 2012, it was estimated that goodwill had been impaired by $5000. The financial statements of Eddie Limited and

Sandy Limited at 31 March 2012 are as follows:

EDDIE LIMITED SANDY LIMITED

($000) ($000)


Revenue 2 000 900Cost of sales 1 400 350


Other income

Profit on sale of fixed asset 180 –

Total income 780 550

Expenses

Depreciation – 130

Other expenses 280 100



Profit for the year 350 224Retained earnings—1 April 2011 400 300

Retained earnings—31 March 2012 750 524


20/44



($000) ($000)


Equity




Loans 400 250

Current liabilities

Tax payable 150 96

2 300 1 370

Non-current assets

Land 730 320

Plant—cost – 780

Plant—accumulated depreciation – 130

– 650

Investment in Sandy Limited 850 –

Current assets

Inventory 420 220


2 300 1 370

Required • Prepare the consolidated financial statement of Eddie Limited and its controlled entity for the reporting period ended

31 March 2012.


The first step is the workings that enable the consolidation journal entry to be prepared.

(a) Eliminating investment in Sandy Limited and recognising goodwill

ELIMINATION OF INVESTMENT IN SANDY LIMITED SANDY ELIMINATE

LIMITED PARENT 100%

($) ($)



Contributed equity 500 000 500 000Retained earnings—on acquisition 300 000 300 000

800 000


Consolidation journal adjustments for 2012



Dr Goodwill 50 000

Cr Investment in Sandy Limited 850 000

Eliminating investment in Sandy Limited and recognising goodwill on acquisition

(b) Reversal of gain recognised on sale of asset and reinstatement of cost and accumulated depreciation (statement of financial position)

The result of the sale of the item of plant to Sandy Limited is that the gain of $180 000 will be shown in Eddie Limited’sfinancial statements. As there has been no transaction with a party outside the economic entity, the following entry is

necessary so that the financial statements will reflect the balances that would have been in place had the intragroup sale not

occurred.

31 March 2012 Dr Gain on sale of asset 180 000

Dr Plant 220 000

Cr Accumulated depreciation 400 000

Reversal of gain recorded in Eddie Limited’s financial statements and reinstatement of accumulated

depreciation


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The result of this entry is that the intragroup gain is removed and the asset and accumulated depreciation account is restated

to that reported by Eddie Limited prior to the sale. The gain of $180 000 will be recognised progressively in the consolidated

financial statements of the economic entity by adjustments to the amounts of depreciation charged by Sandy Limited in its

financial statements. As the service potential or economic benefits embodied in the asset are consumed, the $180 000

profit will be progressively recognised from the economic entity’s perspective. This is shown in journal entry (d).

(c) Impact of tax on gain on sale of asset

Eddie Limited would have recorded a related income tax expense of $180 000 × 30 per cent. From the economic entity’s

perspective no gain has been made, which means that the income tax expense must be reversed. A deferred tax asset

is recognised because, from the group’s perspective, the amount paid to the Inland Revenue Department represents a

prepayment of tax.31 March 2012 Dr Deferred tax asset 54 000


Reducing related income tax expense

(d) Restating statement of financial position accumulated depreciation

Sandy Limited would be depreciating the asset by $780 000 ÷ 6 = $130 000. From the economic entity’s perspective, the

depreciation charge should be $600 000 ÷ 6 = $100 000 (originally $1 000 000 ÷ 10).

31 March 2012 Dr Plant—accumulated depreciation 30 000

Cr Depreciation 30 000

Reducing depreciation expense

(e) Consideration of tax effect of reduction of depreciation expense

The increase in the income tax expense is due to the reduction in the depreciation expense. The additional income tax expense

is $9000 ($30 000 × 30%). This entry represents a partial reversal of the deferred tax asset of $54 000 recognised in theearlier entry. After six periods, the balance of the deferred tax asset related to the sale of the non-current asset will be $nil.

31 March 2012 Dr Income tax expense 9 000

Cr Deferred tax asset 9 000

Recognising increase in income tax expense

(f) Impairment of goodwill

This entry recognises the impairment loss on goodwill for the current year:



Impairment of goodwill for year


Eddie Limited and its controlled entity


ELIMINATIONS AND

EDDIE SANDY ADJUSTMENTS CONSOLIDATED


($000) ($000) ($000) ($000) ($000)


RETAINED EARNINGS

Revenue 2 000 900 2 900

Cost of sales 1 400 350 1 750

Gross profit 600 550 1 150

Other income

Profit on sale of asset 180 – 180(b) –

Total income 780 550 1 150

Expenses

Depreciation – 130 30(d) 100

Other expenses 280 100 5(f) 385

Profit before tax 500 320 665

Income tax expense 150 96 9(e) 54(c) 201


22/44


ELIMINATIONS AND



($000) ($000) ($000) ($000) ($000)


Retained earnings—1 April 2011 400 300 300(a) 400



Equity




Loans 400 250 650

Current liabilities

Tax payable 150 96 246

2 300 1 370 2 760

Non-current assets

Land 730 320 1 050

Plant—cost – 780 220(b) 1 000

Plant—accumulated depreciation – 130 30(d) 400(b) 500

– 650 500

Investment in Sandy Limited 850 – 850(a) –

Goodwill – – 50(a) 50

Accumulated impairment—goodwill 5(f) 5

45

Current assets

Inventory 420 220 640


Deferred tax asset – – 54(c) 9(e) 45

2 300 1 370 2 760

To illustrate how to take account of prior period adjustments (such as adjustments relating to a prior period sale of a non-current asset) when a consolidation is undertaken in periods subsequent to the first consolidation, in Worked Example 25.6the consolidation of Eddie Limited and its controlled entity is undertaken at 31 March 2013—that is two years after controlof the subsidiary was established.

WORKED EXAMPLE 25.6■ CONSOLIDATION TWO YEARS AFTER ACQUISITION IN THE PRESENCE OF A PRIOR PERIOD

INTRAGROUP SALE OF A NON-CURRENT ASSET

The financial statements of Eddie Limited and Sandy Limited at 31 March 2013 are as follows:


($000) ($000)


Revenue 2 700 1 100

Cost of sales 1 550 440

Gross profit 1 150 660

Expenses

Depreciation – 130

Other expenses 410 120


23/44



($000) ($000)




Retained earnings—1 April 2012 750 524



Equity




Loans 390 245

Current liabilities

Tax payable 222 123

2 880 1 679

Non-current assets

Land 910 320

Plant—cost – 780

Plant—accumulated depreciation – 260

– 520

Investment in Sandy Limited 850 –

Current assets

Inventory 820 559


2 880 1 679

Required • Prepare the consolidated financial statement of Eddie Limited and its controlled entity for the reporting period

ended 31 March 2013, assuming that the directors believe that goodwill on acquisition has been impaired by a further $5000.

In undertaking the consolidation the profit made on the sale, discussed in Worked Example 25.5, needs to be taken into a

ccount.

Solution to Worked Example 25.6As the workings for the consolidation journal entry were prepared earlier, they are not repeated here.

Consolidation journal adjustments for 2013

(a) Eliminating investment and recognition of goodwill



Dr Goodwill 50 000

Cr Investment in Sandy Limited 850 000

Eliminating investment in Sandy Limited and recognising goodwill

(b) Reversal of profit on sale of asset recognised in the previous period, and reinstatement of cost and accumulated depreciation

This entry reinstates the asset cost and accumulated depreciation, and eliminates the profit on the sale of the asset

recognised in the previous period.

31 March 2013 Dr Retained earnings—1 April 2012 126 000Dr Deferred tax asset 54 000

Dr Plant 220 000


Consolidation adjustment eliminating gain on sale of assets

[The debit to retained earnings = the gain on sale × (1 – tax rate) = $180 000 × 0.7.]


24/44


(c) Depreciation adjustment for current and prior period

This entry is necessary to restate the accumulated depreciation to what it would have been had the sale of the asset not occurred.


Cr Depreciation expense 30 000

Cr Retained earnings—1 April 2012 30 000

Depreciation adjustment for the current and prior period

(d) Tax consideration on current and previous periods’ depreciation

This entry takes into account the tax effect of the reduction in the depreciation charge.

31 March 2013 Dr Retained earnings—1 April 2012 9 000



Tax effects of current and previous periods’ depreciation adjustments

With tax-effect accounting, each decrease of $30 000 in depreciation leads to an increase in accounting income of $30 000

and an associated increase in income tax expense of $18 000 ($30 000 × 30%).

(e) Impairment of goodwill

This entry recognises the goodwill impairment loss for the period. The retained earnings adjustment that takes into account

the goodwill impairment loss of the previous period is made in the next entry.




Goodwill impairment loss for current and prior periods

The consolidation worksheet can now be prepared, as follows.Eddie Limited and its controlled entity


ELIMINATIONS AND



($000) ($000) ($000) ($000) ($000)


RETAINED EARNINGS

Revenue 2 700 1 100 3 800

Cost of sales 1 550 440 1 990

Gross profit 1 150 660 1 810

ExpensesDepreciation expense – 130 30(c) 100

Other expenses 410 120 5(e) 535

Profit before tax 740 410 1 175

Income tax expense 222 123 9(d) 354


Retained earnings—1 April 2012 750 524 300(a) 30(c)

126(b)

9(b)

5(e) 864

Retained earnings—31 March 2013 1 268 811 1 685


EquityContributed equity 1 000 500 500(a) 1 000

Retained earnings b/d 1 268 811 1 685


Loans 390 245 635

Current liabilities

Tax payable 222 123 345

2 880 1 679 3 665


25/44


ELIMINATIONS AND



($000) ($000) ($000) ($000) ($000)

Non-current assets

Land 910 320 1 230

Plant—at cost – 780 220(b) 1 000

Plant—accumulated depreciation – 260 60(c) 400(b) 600

– 520 400Investment in Sandy Limited 850 – 850(a) –

Goodwill—at cost 50(a) 50

Goodwill—accum. impairment loss 10(e) 10

40

Current assets

Inventory 820 559 1 379


Deferred tax asset – – 54(b) 18(d) 36

2 880 1 679 3 665

The consolidated financial statements can now be prepared:

Eddie Limited and its controlled entityConsolidated statement of comprehensive income for the year ended 31 March 2013

GROUP EDDIE LIMITED

($) ($)

Sales 3 800 000 2 700 000

Cost of goods sold (1 990 000) (1 550 000)

Gross profit 1 810 000 1 150 000

Depreciation (100 000) –

Other expenses (535 000) (410 000)

Profit before tax 1 175 000 740 000

Income tax expense (354 000) (222 000)

Profit for the year 821 000 518 000Other comprehensive income – –

Total comprehensive income for the year 821 000 518 000



GROUP

CONTRIBUTED RETAINED TOTAL

EQUITY EARNINGS EQUITY

($000) ($000) ($000)

Balance at 1 April 2012 1 000 864 1 864

Total comprehensive income for the year 821 821Distributions—Dividends – –

Balance at 31 March 2013 1 000 1 685 2 685


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Eddie Limited


EDDIE LIMITED


EQUITY EARNINGS TOTAL

($000) ($000) ($000)

Balance at 1 April 2012 1 000 750 1 750


Distributions – –

Balance at 31 March 2013 1 000 1 268 2 268



GROUP EDDIE LIMITED

($) ($)

Current Assets

Accounts receivable 580 000 300 000

Inventory 1 379 000 820 000

1 959 000 1 120 000

Non-current assetsLand 1 230 000 910 000

Plant and equipment 1 000 000 –

Accumulated depreciation (600 000) –

400 000 –

Deferred tax asset 36 000 –

Goodwill 50 000 –

less Accumulated impairment loss (10 000) –

40 000 –

Investment in Sandy Limited – 850 000

1 706 000 1 760 000

Total assets 3 665 000 2 880 000

Current liabilities

Tax payable 345 000 222 000


Loan 635 000 390 000

Total liabilities 980 000 612 000

Equity

Contributed equity 1 000 000 1 000 000

Retained earnings 1 685 000 1 268 000

Total equity 2 685 000 2 268 000

3 665 000 2 880 000

INTRAGROUP SALES OF DEPRECIABLE NON-CURRENT ASSETS WHEN THEIR ESTIMATED

TOTAL USEFUL LIFE CHANGES ON ACQUISITION

It is important to remember that the sale of a non-current asset might result in the depreciation rate charged by the purchaserdiffering from that charged by the seller. In addition, the purchaser of a non-current asset might utilise the asset in a differentmanner, in a different location and for a different purpose. These changes result in the service potential or future economic

benefits embodied in the asset being consumed by the purchaser of the asset at a rate different from that of the seller. The


27/44


depreciation charge in the consolidated financial statements should be adjusted to reflect the purchaser’s changed expectation.This is consistent with the requirement of NZ IAS 16 ‘Property, Plant and Equipment’, paragraph 51, which requires theresidual value and the useful life of an item of property, plant and equipment to be reviewed at least at the end of each reportingperiod and, where expectations differ from previous estimates, the change to be accounted for as a change in an accountingestimate as required by NZ IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’ (see Chapter 17 for anexplanation of how a change in accounting estimate should be made). What this means is that where the original useful life ofan item of property, plant and equipment is no longer appropriate, the depreciation charge for the current and future periodsmust be reviewed and, if necessary, adjusted. The consolidation adjustments that should be made where the useful life of anon-current asset sold intragroup changes are detailed in Worked Example 25.7.

WORKED EXAMPLE 25.7■ INTRAGROUP SALE OF A NON-CURRENT ASSET WHERE USEFUL LIFE CHANGES

Assume the same information as provided for Worked Example 25.5, except that in this example the remaining useful life of the

depreciable non-current asset sold by Eddie Limited to Sandy Limited is assessed as being four years.

Required • Prepare the journal entries necessary to account for the sale of the non-current asset for the years ending

31 March 2012 and 31 March 2013.


(a) Reversal of gain recognised on sale of asset and reinstatement of cost and accumulated depreciation

The result of the sale of the item of plant to Sandy Limited is that the profit of $180 000 will be shown in Eddie Limited’s

financial statements. As there has been no transaction with a party outside the economic entity, the following entry is

necessary so that the financial statements will reflect the balances that would have been in place had the intragroup sale

not occurred.

31 March 2012 Dr Gain on sale of asset 180 000

Dr Plant 220 000


Reversal of gain recorded in Eddie Limited’s financial statements and reinstatement of accumulated

depreciation

(b) Impact of tax on profit of sale of asset

Eddie Limited would have recorded a related income tax expense of $180 000 × 30 per cent. From the economic entity’s

perspective no gain has been made, which means that the income tax expense must be reversed. A deferred tax asset

is recognised because, from the group’s perspective, the amount paid to the Inland Revenue Department represents a

prepayment of tax.


Cr Income tax expense 54 000 Reducing related income tax expense

(c) Restating statement of financial position accumulated depreciation

Sandy Limited would be depreciating the asset by $780 000 ÷ 4 = $195 000. From the economic entity’s perspective, the

depreciation should be $600 000 ÷ 4 = $150 000.


Cr Depreciation 45 000

Reducing depreciation expense

(d) Consideration of tax effect of reduction of depreciation expense

The increase in the income tax expense is due to the reduction in depreciation expense. The additional income tax expense

is $13 500 ($45 000 × 30%). This entry represents a partial reversal of the deferred tax asset of $54 000 recognised in the

earlier entry. After four periods, the balance of the deferred tax asset related to the sale of the non-current asset will be nil.

31 March 2012 Dr Income tax expense 13 500Cr Deferred tax asset 13 500

Recognising increase in income tax expense

Consolidation journal adjustments for 31 March 2013

(e) Reversal of gain on sale of asset recognised in the previous period, and reinstatement of cost and accumulated depreciation

This entry reinstates the asset cost and accumulated depreciation, and eliminates the gain on sale of the asset recognised

in the previous period.


28/44


31 March 2013 Dr Retained earnings—31 March 2012 126 000

Dr Deferred tax asset 54 000

Dr Plant 220 000


Consolidation adjustment eliminating gain on sale of assets

[The debit to retained earnings = the gain on sale × (1 – tax rate) = $180 000 × 0.7.]

(f) Depreciation adjustment for current and prior period

This entry is necessary to reinstate the accumulated depreciation to what it would have been had the sale of the asset not

occurred.

31 March 2013 Dr Accumulated depreciation 90 000

Cr Depreciation expense 45 000

Cr Retained earnings—31 March 2012 45 000

Depreciation adjustment for the current and prior periods

(g) Tax consideration on current and previous periods’ depreciation

This entry takes into account the tax effect of the reduction in the depreciation charge.

31 March 2013 Dr Retained earnings—31 March 2012 13 500



Tax effects of current and previous periods’ depreciation adjustments

By adopting tax-effect accounting, each decrease of $45 000 in depreciation leads to an increase in accounting income of

$45 000 and an associated increase in income tax expense of $13 500 ($45 000 × 30%).

INTRAGROUP SALE OF A NON-CURRENT ASSET RESULTING IN A LOSS

Where a loss is made on the intragroup sale of a non-current asset, the treatment is similar to that where a profit is made on anintragroup transaction. However, the entries to account for depreciation shown in Worked Example 25.6, for example, wouldneed to be reversed, while the tax-effect entry would reduce the deferred tax asset that was created as a result of the loss.

It is, of course, possible for a non-current asset that is sold within the economic entity to change its classification on sale.For example, an item of inventory in one entity within the economic entity might become a non-current asset and might beused in the manufacturing process of another company within the economic entity. From the legal entity’s perspective, therehas been a sale of inventory and the acquisition of a non-current asset. From the economic entity’s perspective, however,there has been no sale of inventory and no acquisition of a non-current asset. There has merely been a reclassification of anitem of inventory as a non-current asset.

SUMMARY

The chapter considered the consolidation process and, in particular, how to account for intragroup transactions—that is,

intragroup dividend payments, sales of inventory and sales of non-current assets.

The chapter indicated that only dividends paid externally should be shown in the consolidated financial statements, so

that intragroup dividends paid by one entity within the group are offset against dividend revenue recorded in another entity.

Further, for intragroup dividends, the liability associated with dividends payable is to be offset against the asset, dividend

receivable, as recorded by other entities within the group.

Individual entities within a group often provide goods and services to one another at a profit. From the economic entity’s

perspective, however, revenue related to the sale of goods and services should be shown only where the inflow of economic

benefits has come from parties external to the group. As such, on consolidation it is often necessary to provide adjusting

entries that eliminate the effects of intragroup sales. Where there have been intragroup sales and some of the inventory is

still on hand within the group at the end of the reporting period, consolidation adjustments will need to be made that reduce

the consolidated balance of closing inventory. This is required to ensure that the consolidated financial statements measure

inventory at the lower of cost and net realisable value from the group’s perspective (consistent with NZ IAS 2).

Where there is a sale of non-current assets within the group, consolidation adjustments are to be made to eliminate any

intragroup profit on the sale of the assets and to adjust the cost of the assets to reflect their cost to the economic entity.

Where there are intragroup sales of non-current assets there is also, typically, a requirement to adjust depreciation as part

of the consolidation process.


29/44


KEY TERM

intragroup transactions 815

END-OF-CHAPTER EXERCISE

PART A

After completing this chapter, readers should be able to provide answers to the following questions. (If they are not able to,

the relevant sections of this chapter should be reviewed.)

1 Following consolidation, should dividends paid to the parent entity by its subsidiaries be shown in the economic entity’s

financial statements?

2 Will dividends paid by subsidiaries out of their pre-acquisition earnings affect the amount of goodwill that will be calculated

on consolidation?

3 If a subsidiary sells inventory to the parent entity and some of the inventory is still on hand at the end of the reporting

period, what adjustments are necessary at the end of the reporting period? Will adjustments be required to restate the

balance of opening inventory as at the beginning of the next financial period?

PART B

The following financial statements of Mungo Limited and its subsidiary Barry Limited have been extracted from their financial

records at 31 March 2012.

MUNGO LIMITED BARRY LIMITED

($000) ($000)


Sales revenue 1 380.0 1 160.0

Cost of goods sold (928.0) (476.0)

Gross profit 452.0 684.0

Dividends received from Barry Limited 186.0 –

Management fee revenue 53.0 –

Gain on sale of plant 70.0 –

Expenses

Administrative expenses (98.8) (77.4)

Depreciation (49.0) (113.6)

Management fee expense – (53.0)

Other expenses (202.2) (154.0)

Profit before tax 411.0 286.0

Income tax expense 123.0 84.4

Profit for the year 288.0 201.6

Retained earnings—1 April 2011 638.8 478.4

926.8 680.0

Dividends paid (274.8) (186.0)

Retained earnings—31 March 2012 652.0 494.0


Equity

Contributed equity 700.0 400.0

Retained earnings b/d 652.0 494.0

Current liabilities

Accounts payable 109.4 92.6

Tax payable 82.6 50.0


Loans 347.0 232.0

1 891.0 1 268.6


30/44


MUNGO LIMITED BARRY LIMITED

($000) ($000)

Current assets

Accounts receivable 118.8 124.6

Inventory 184.0 58.0

Non-current assets

Land and buildings 448.0 652.0

Plant—at cost 599.7 711.6

Accumulated depreciation (171.5) (277.6)

428.2 434.0

Investment in Barry Limited 712.0 –

1 891.0 1 268.6

Other information •

• Mungo Limited acquired its 100 per cent interest in Barry Limited on 1 April 2008, that is four years earlier. The payment

for the interest in Barry Limited represented the fair value of the consideration transferred. At that date the contributed

equity and reserves of Barry Limited were:

$


Retained earnings 250 000 650 000

At the date of acquisition all assets were considered to be fairly valued.

• During the year Mungo Limited made total sales to Barry Limited of $130 000, while Barry Limited sold $104 000 in

inventory to Mungo Limited.

• The opening inventory in Mungo Limited as at 1 April 2011 included inventory acquired from Barry Limited for $84 000

that had cost Barry Limited $70 000 to produce.

• The closing inventory in Mungo Limited includes inventory acquired from Barry Limited at a cost of $67 200. This cost

Barry Limited $52 000 to produce.

• The closing inventory of Barry Limited includes inventory acquired from Mungo Limited at a cost of $24 000. This cost

Mungo Limited $19 200 to produce.

• The management of Mungo Limited believe that goodwill acquired was impaired by $5000 in the current reporting period.

Previous impairments of goodwill amounted to $10 000.• On 1 April 2011 Mungo Limited sold an item of plant to Barry Limited for $100 000 when its carrying value in Mungo

Limited’s financial statements was $80 000 (cost $120 000, accumulated depreciation $40 000). This plant is assessed

as having a remaining useful life of six years from the date of sale.

• Barry Limited paid $53 000 in management fees to Mungo Limited.

• The tax rate is 30 per cent.

Required • Prepare the consolidated financial statement of Mungo Limited and its controlled entity for the reporting period

ended 31 March 2012.

Solution to Part B

(a) Elimination of the investment in Mungo Limited and the recognition of goodwill on acquisition date

ELIMINATION OF INVESTMENT IN BARRY LIMITED BARRY ELIMINATE

LIMITED PARENT 100%

($) ($)





650 000



31/44


As shown above, the net assets of Barry Limited are $650 000 on acquisition date. As $712 000 is paid for the

investment, the goodwill amounts to $62 000. The consolidation entry to eliminate the investment is:



Dr Goodwill 62 000

Cr Investment in Barry Limited 712 000

Eliminating investment in Sandy Limited and recognising goodwill

Adjustments for intragroup sales

(b) Elimination of intragroup sales

The intragroup sales need to be eliminated because, from the perspective of the economic entity, no sales have in factoccurred. This will ensure that the turnover of the economic entity is not overstated.

31 March 2012 Dr Revenue—sales Barry Limited 104 000

Cr Cost of goods sold 104 000

Eliminating sale of inventory from Barry Limited to Mungo Limited

Under the periodic inventory system, the above credit entry would instead be to purchases, which would ultimately

lead to a reduction in cost of goods sold. (Cost of goods sold equals opening inventory plus purchases less closing

inventory, so any reduction in purchases leads to a reduction in cost of goods sold.)

(c) Elimination of the unrealised profit in the closing inventory of Mungo Limited

In this case, the unrealised profit in closing amounts to $15 200. In accordance with NZ IAS 2 ‘Inventories’, the

inventory must be valued at the lower of cost and net realisable value. Therefore on consolidation the value of recorded

inventory must be reduced as the amount shown in the financial statements of Mungo Limited exceeds what the

inventory cost the economic entity.31 March 2012 Dr Cost of goods sold 15 200

Cr Inventory 15 200


Under the periodic inventory system, the above debit entry would be to closing inventory—profit and loss. The cost

of goods sold is increased by the unrealised profit in closing inventory because reducing closing inventory effectively

increases cost of goods sold. (Remember, cost of goods sold equals opening inventory plus purchases less closing

inventory.) The effect of the above entries is to adjust the value of inventory so that it reflects the cost of the inventory

to t

Accounting for Intra Group Transactions

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